For something I’m working on: we know that China is pursuing a mercantilist policy: keeping the renminbi weak through a combination of capital controls and intervention, leading to trade surpluses and capital exports in a country that might well be a natural capital importer. We also know, or should know, that this amounts to a beggar-thy-neighbor policy “” or, more accurately, a beggar-everyone but yourself policy “” when the world’s major economies are in a liquidity trap.

But how big is the impact? Here’s a quick back-of-the-envelope assessment.

Start with the Chinese surplus. It has been temporarily depressed by the world trade collapse, but seems to be on the rise again. Blanchard and Milesi-Ferretti, at the IMF but speaking for themselves, project a Chinese current account surplus for 2010-2014 of 0.9 percent of gross world product.

. . .

In turn, this negative shock is like a negative shock to government purchases of goods and services. So it should have a similar multiplier. Multiplier estimates are all over the place, but tend to cluster around 1.5. So we’re looking at a negative impact on gross world product of around 1.4 percent. Not huge “” China isn’t the principal obstacle to recovery “” but significant.

And, if we think of the United States as bearing a proportionate share, and also use the rule of thumb that one point of GDP = 1 million jobs, we’re looking at 1.4 million U.S. jobs lost due to Chinese mercantilism.

Let’s start with the data. Because I couldn’t find CA surplus forecasts, I’ll use trade data. (Isn’t it trade surpluses that are a problem in the Keynesian model?) In any case, the Chinese trade surplus was $295 billion in 2008 and $198 billion in 2009. This year it is expected to fall to $160 billion. If you believe in silly Keynesian C+I+G+NX “models,” then the change in China’s surplus has recently been a net positive for the rest of world. And $160 billion is barely 1% of US GDP.

But let’s assume Krugman is right and that the trade surplus gets much bigger in the out years. What then? According to Krugman’s own model these surpluses only depress output if you are in a liquidity trap and can’t get out. He sees the US economy as like that old codger on those TV commercials (“I’ve fallen and I can’t get up.”) But almost no one thinks we are going to be in a liquidity trap in 2014, indeed many believe the Fed will begin its so-called “exit strategy” this year. If so, that would completely invalidate Krugman’s argument.

But it is even worse. Even Krugman doesn’t think we’ve fallen and can’t get up. He has repeatedly emphasized that the Fed could still boost AD via inflation targeting. The real problem is we’ve fallen and we won’t get up. But if the US has the ability to raise NGDP through monetary policy, then the failure to do that is the US’s fault, not China’s. China’s trade surplus has zero effect on US employment if we aren’t “trapped.”

BTW, I notice that Germany’s trade surplus over the past 12 months is $168.8 billion. Saudi Arabia’s is $212 billion. Yes, Germany is in the eurozone, but after all, they could leave the eurozone and revalue their currency upward. I doubt Krugman would be mollified if China adopted the US dollar at the current dollar/yuan exchange rate and continued running surpluses. One of the things I always disliked about Pat Buchanan is that he seemed to favor trade barriers against Asian countries, but not white countries. I’d hate to see a liberal like Krugman slip into that trap, even if only accidentally.

Update 1/4/10: Someone suggested that my wording implied Krugman’s motives were suspect. That wasn’t my intent. I tried to suggest that singling out China might unintentionally give aid and comfort to others who do have a racial agenda. I regret any misunderstanding. People should be free to offer policy views without having their motives impugned. (As I’m sure Krugman agrees.)

You might be thinking “wait a minute, the post you linked to doesn’t advocate trade barriers aimed specifically at China.” No but this one seems to:

Let me quote from a classic paper by the late Paul Samuelson, who more or less created modern economics: “With employment less than full … all the debunked mercantilistic arguments” “” that is, claims that nations who subsidize their exports effectively steal jobs from other countries “” “turn out to be valid.” He then went on to argue that persistently misaligned exchange rates create “genuine problems for free-trade apologetics.” The best answer to these problems is getting exchange rates back to where they ought to be. But that’s exactly what China is refusing to let happen.

The bottom line is that Chinese mercantilism is a growing problem, and the victims of that mercantilism have little to lose from a trade confrontation.

Now it seems you no longer need a liquidity trap, just employment that is “less than full.” Of course politicians think employment is always “less than full,” so this opens the door to almost unlimited trade wars. (Note, Krugman is right and Samuelson is wrong, monetary policy must be “trapped.”)

There are many other problems with Krugman’s argument; so many one hardly knows where to start.

1. It is misleading to focus on exchange rates. Changing the nominal exchange rate does not eliminate trade imbalances if the underlying forces remain in place. The yen has risen from 360 to the dollar in the 1960s to 85 to the dollar, and they continue to run big CA surpluses. Indeed all the big East Asian economies do, often much larger as a share of GDP than China. And some are relatively open economies, without exchange controls. The reason is simple; these are high saving nations with very low population growth. When Japan was pressured to raise its nominal exchange rate they ended up with deflation, so their real exchange rate remains highly competitive. When the Chinese yuan became overvalued during the East Asian crisis of 1997-98 they did not devalue, instead they experienced deflation until their real exchange rate was again competitive. When the yuan became undervalued in 2005, China experienced rising inflation. Nominal exchange rate changes, by themselves, solve nothing. I do think Krugman understands this as he also mentions the underlying drivers of China’s surplus:

Under normal circumstances, the inflow of dollars from those surpluses would push up the value of China’s currency, unless it was offset by private investors heading the other way. And private investors are trying to get into China, not out of it. But China’s government restricts capital inflows, even as it buys up dollars and parks them abroad, adding to a $2 trillion-plus hoard of foreign exchange reserves.

This is the real issue. It is not about “subsidizing exports” (the sort of crude argument Krugman used to ridicule in his Pop Internationism days.) Indeed contrary to what he says in this editorial, the Chinese government favors big SOEs, not the predominantly private exporters. No, the real issue is China’s fiscal policy. In other East Asian countries that have a high CA surplus, notably Singapore, there is a very high rate of savings. This reflects the fact that Singapore has perhaps the world’s best fiscal policy regime. China is still half communist and very underdeveloped. They cannot simply wave a magic wand and copy Singapore. But if they are smart (and I think they are) they understand that the Singapore high-saving model is much more sensible that the Western system of unfunded social insurance schemes. So they have accumulated a nice $2 trillion dollar nest egg. That may seem large, but when you think about the looming demographic nightmare they face, it is arguably far too small to set up a Singapore-type regime in the future. China’s official GDP is only about $5 trillion, but in the blink of an eye it will be $20 or $30 trillion (due to 10% real growth, inflation, and yuan appreciation that will resume by 2011.) They will soon need a much bigger nest egg.

To summarize, if we give Krugman the benefit of the doubt he isn’t so much asking for a higher nominal exchange rate, but rather for the Chinese government to stop saving so much. BTW, what does this imply about the other East Asian countries that run surpluses because their private citizens save so much, often because they are forced to by the government? Should we also put tariffs on their exports?

2. Now let’s assume that everything I’ve said about Chinese government saving is wrong. After all, it is a poor country. And there are good counterexamples; Korea usually ran CA deficits during its 1960s-90s high growth phase. Even in that case Krugman’s argument is completely indefensible on both practical and moral grounds. For the moment let’s stop obsessing about our unemployment problem, and spare a thought for the millions of Chinese workers in coastal factories who were thrown out of work during late 2008 and early 2009. Who’s to blame for that crisis? I am pretty sure Krugman would say we are. He thinks that the financial crisis of 2007-08 was caused by reckless policies in the US and in some European countries as well. So we are to blame for the deflationary shock that hit the world economy in late 2008.

Now ask yourself what Keynesians think a central bank should do when faced with a deflationary world environment. Krugman’s hero Keynes said FDR was “magnificently right” when he sharply devalued the dollar in 1933, even though we had a trade surplus and even though Keynes was British. The devaluation was seen (correctly) as a way of reversing the deflation. And it worked. Indeed Krugman’s colleague Svensson called devaluation a foolproof way out of a liquidity trap, and recommended Japan adopt this policy. And Japan also has big CA surpluses.

But China did not devalue, just as they refrained from devaluing in the 1997-98 Asian crisis. All they did is temporarily halt their ongoing policy of currency appreciation. As a result they still suffered some deflation in 2008-09. Furthermore they adopted a massive fiscal stimulus, surely a policy that Krugman would approve of. So the combined effects of this fiscal stimulus (widely seen as the world’s most effective in this crisis), and the monetary stimulus provided by putting currency appreciation on hold, was still not enough to prevent deflation. But apparently this is still too much for Krugman. He favors an even higher value of the yuan, which would have meant even steeper deflation in China.

But it’s even worse than this. As I noted above, even Krugman doesn’t think that the unemployment suffered by the villains of the story (The US, UK, Spain, Iceland, etc) is caused by China. We created the crisis, and then we in the US failed to adopt the sort of inflation targeting that could have prevented a big fall in US aggregate demand. So let’s summarize Krugman’s apparent views and other generally accepted facts:

1. The US and other rich countries created this worldwide macroeconomic disaster through reckless policies.

2. Many innocent bystanders such as Chinese workers lost jobs as a result of US policies.

3. China is running a trade surplus due to government saving, but the deflationary impact of that surplus on the US could be offset with inflation targeting.

4. The Fed refuses to engage in effective monetary stimulus, and is on the verge of tightening policy.

5. Therefore let’s blame the Chinese.

How does Krugman think the richest country in world history should react to its own shameful policy incompetence? He seems to think we should follow the example of Herbert Hoover and adopt protectionist policies. Even worse, protectionist policies aimed at 1.3 billion mostly poor people. Here is a question for sensible Democrats like Matt Yglesias, Brad DeLong and Mark Thoma: Is that the sort of leadership from Obama that would restore US standing with the rest of the world?

Part 2. China saved the (third) world in 2009.

Not only is China not to blame for the world’s problems, but the stimulus achieved by stabilizing the yuan and encouraging bank lending led to a surprising boom after March 2009. As this article points out, this led to the fastest annual gain in commodity prices in 40 years (albeit from a low base last winter):

Dec. 31 (Bloomberg) — Commodities posted the biggest annual gain in four decades, led by a doubling in copper, sugar and lead prices, as Chinese demand compensated for the longest slump in the global economy since World War II.

In 2009, the S&P GSCI Index of 24 raw materials rose 50 percent, the most since at least 1971, and commodities drew record investment of $60 billion this year, Barclays Capital estimated. This year, the MSCI World Index of stocks in 23 developed nations climbed 27 percent, and U.S. Treasuries fell 3.5 percent, according to Bank of America Merrill Lynch indexes.

China, the biggest consumer of commodities such as copper and iron ore, expanded 8.5 percent this year, according to the median estimate of economists surveyed by Bloomberg. The nation imported record amounts of both raw materials this year, making up for slack demand in the U.S. and Europe.

This is the single most important reason why commodity producers from Brazil to Indonesia to Russia were able to do much better than expected in 2009. Those three countries all saw their stock markets more than double in dollar terms. Overall, stocks in developing countries rose 72% in dollar terms as of December 19th, while developed markets rose 27%. Most people live in the third world, and of course they are much poorer than we are. In pure utilitarian terms the Chinese weak yuan policy was the single best thing that happened in 2009. In contrast, our shameful policies destroyed a lot of wealth both here and abroad.

Thank God the Chinese can’t be bullied into a deflationary policy of appreciating the yuan prematurely. We all saw what happened in Japan.

Update: I am embarrassed to admit that Matt Yglesiashas already made the same argument. That makes my challenge look kind of silly. There is only one area where Matt and I differ; I never “hesitate to disagree” with Krugman. Next time I must remember to read Matt’s blog before I challenge him.

And the man got his nobel for trade theory. He is a bone ignorant fool. And a stunning danger. In addition to being an arrogant ass. His first policy suggestion was to nationalize the banks. Straight deflationary. And now he promotes a trade war. Good Lord.

If memory serves, a long time ago on this blog (at its former address of course) you quoted someone from China as saying something to the effect of, “world famous economist Scott Sumner”.

I’d say that you shouldn’t discount the possibility that the Chinese economic establishment (for lack of more informed framing) somewhere along the line read your papers (and possibly from other economists) regarding NGDP expectations and the (im)balance of demand and supply of holding money, and that they drew the appropriate conclusions and have henceforth tailored policy in part from that framework.

Over the past few years I’ve realized that Chinese government officials seem to have a radically better understanding of economics than their US counterparts, or from their counterparts elsewhere around the world for that matter, possibly excepting Singapore, Hong Kong et al.

You’ve radically changed my point of view, via your blog, regarding monetary policy from roughly Friedmanesque to something far more nuanced and hopefully(!) correct. The notion of Hayek’s (was he the original, or merely the most famous expositor?) “secondary depression” was an eye opener, as was/is the radical notion of NGDP futures targeting leading to possibly quasi-zero recessions for any country astute enough to follow that prescription.

Anyway, I am happy to see this post regarding China and its exchange rate and the whole beggar thy neighbor myth exposition. I am repeatedly disturbed by how many people (who ought to know better) that don’t quite get it regarding China’s fixed exchange rate and its implications for how tight or loose its monetary policy then has to be.

You continue to make the argument by forcing a coupling of policies that do not need to be coupled. You and Krugman are both trying to knock down straw men here…

The Chinese could EASILY retain the current dollar/yuan exchange rate by letting the Yuan float, and then increasing the Yuan supply sufficiently to achieve the current nominal exchange rate. Why, precisely, is this worse than the current China policy of using capital controls and forced exchange accumulation to achieve the same thing?

– If it’s desirable for China to maintain an undervalued Yuan using exchange controls instead of money supply, why isn’t it also desirable for the US to do the same? (We, too, have an aging population and could use the savings…)

– If you believe in the free market, why can’t the Chinese be trusted to save for themselves, instead of relying on a paternalistic government to save for them?

– If the current exchange rate is desirable (in some efficiency sort of way), then why isn’t it desirable for China to inflate its money supply to achieve the current rate?

– You write “Thank God the Chinese can’t be bullied into a deflationary policy of appreciating the yuan prematurely.”

To which I reply: “If only Geithner/Bernanke had shown the same resistance to being bullied by the Chinese into opposing dollar depreciation.” Remember this?

“U.S. Treasury Secretary Timothy Geithner on Monday reassured the Chinese government that its huge holdings of dollar assets are safe and reaffirmed his faith in a strong U.S. currency.”

China did not act in its current path because of any great meta-understanding of world macroeconomics or higher order concern over world utility… Otherwise, it would not simultaneously be keeping the Yuan low and insisting that we keep the dollar high. The difference is this:

They were smart enough to ignore us, and we are dumb enough to bow to their pressure.

Back to Krugman:

Krugman makes a stretched slaim – 1.4 million jobs lost. “You can think of this as a negative shock to rest-of-world net exports.” Your response (previously) was that the income effect dominates, which I now understand (thank you) – and in the context of demand crisis driven by mass hysteria, I don’t pretend any great power to observe the “truth”. Certainly there is a direct displacement effect, but as to the short term effect of thousands of factories (with fixed production assets) in China going insolvent? Who knows. Thus, I don’t necessarily care for this form of the argument.

The long term argument, however – that 20 years of Chinese trade surpluses has harmed US labor more than it would have in the absence of Chinese capital controls – is significantly stronger (but not unique to the Chinese). Notably, you seem to leave an out for yourself – “appreciating the yuan prematurely”. I guess a lot depends on the definition of ‘premature’ in this particular instance. Do you mean that the Yuan should avoid appreciation until the demand crisis phase has passed, or that it should avoid appreciation until some other set of events occurs?

“…spare a thought for the millions of Chinese workers in coastal factories who were thrown out of work during late 2008 and early 2009. Who’s to blame for that crisis? I am pretty sure Krugman would say we are.”

If you mean immediate cause, yes. But, why were so many Chinese factory workers employed in factories that were slavishly dependent on exports to a country that was consuming far more than it produced? Who created this dependence?

So are you arguing that this dependence was a necessary side effect of a capital control policy that was necessary to help China escape the poverty trap? (If so, I have not yet heard you explicitly make that argument – instead you cite Korea, which ran a very slightly negative CA balance from 1980 to 1995.)

And – are or are you not explicitly endorsing paternalist forced-savings/investment fiscal policies (including for developed countries)? If so, sign me up. I’m totally on board.

As you know the vast majority of those forced savings were given away to State Owned Enterprises often run by communist party cronies. So your endorsement of that policy strikes me as a bit perverse. (Then again I am bedeviled by your infatuation with Singapore, whose regime maybe right-wing, but is certainly not libertarian).

The dollar reserves themselves are fairly useless. What good have all of the reserves the Japanese racked up done them in a deflationary trap for the last twenty years?

As ever, when you post about China I go straight over to Pettis’s blog to see what he’s saying. While he mentions Krugman’s article as an example of rising trade tensions, he doesn’t substantively address the content.

He does, however, mention the affect of the current stimulus on China’s SOE’s and small businesses:

There has been a lot of discussion within China about the impact the fiscal stimulus has had on accelerating a process that by some accounts began in the mid-1990s, and by others in the early 2000s, in which the entrepreneurial private sector in China has been squeezed out in favor of the SOE sector. This seems to have found confirmation in the PBoC numbers, according to the article:

The crisis seems to fly in the face of the government’s “relatively loose” monetary policy introduced to battle the economic downturn. However, the explosion in bank credit has been weighted toward large, state-owned companies, and the small firms’ share has been shrinking, despite their vulnerability in the economic crisis.

He also links to a South China Daily article that claims 40% of new loans have found their way into the real estate sector, which is a shade higher than the WSJ claim of 5%. Hard to know where the money’s going. Link below:

Mark, Yes, I am embarrassed that I missed that. I added an update yesterday when I found out.

JimP, At times Krugman seems to let his political instincts overwhelm his knowledge of economic theory.

TGGP, Thanks, that Robin Hanson post does nicely complement my post.

happyjugglerO, Thanks, I appreciate that. But I doubt they pay much attention to my posts. If their policy does reflect my ideas, perhaps I could be compensated at the rate of 1/10th of a cent for each Chinese citizen. That’s doesn’t sound like very much, does it?

Matthew, Sorry I missed that. If you get any money from Beijing let me know.

Statsguy, You said;

“The Chinese could EASILY retain the current dollar/yuan exchange rate by letting the Yuan float, and then increasing the Yuan supply sufficiently to achieve the current nominal exchange rate. Why, precisely, is this worse than the current China policy of using capital controls and forced exchange accumulation to achieve the same thing?

– If it’s desirable for China to maintain an undervalued Yuan using exchange controls instead of money supply, why isn’t it also desirable for the US to do the same? (We, too, have an aging population and could use the savings…)”

Several comments. I agree the Chinese could do exactly as you say, and I think that was implicit in my attempt to separate out the exchange rate issue and the Chinese government saving issue.

2. I don’t agree that the yuan is “undervalued”. Given the Chinese government demand for foreign assets, that is the right value.

3. The US should save much more, we should adopt Singapore’s fiscal policy. Saving is not a zero sum game. All countries can simultaneously save more if they want. Let’s get our own house in order and stop worrying about the Chinese. Does anyone worry about Germany’s $168 billion trade surplus?

You said;

“- If you believe in the free market, why can’t the Chinese be trusted to save for themselves, instead of relying on a paternalistic government to save for them?”

The free market may be first best, but in the real world there are two alternatives: Forced saving or unfunded social insurance. I prefer forced saving, as it doesn’t require high taxes. I’d like to see China adopt Singapore’s system right now, but I don’t think they have the ability to do that yet. It is still a very large and disorganized country. Most people in China pay no income tax.

I am not saying the Chinese did this out of altruistic motives; I agree they did not. But I also doubt we gave in to Chinese pressure. US policy tends to ignore the rest of the world.

You said;

“The long term argument, however – that 20 years of Chinese trade surpluses has harmed US labor more than it would have in the absence of Chinese capital controls – is significantly stronger (but not unique to the Chinese). Notably, you seem to leave an out for yourself – “appreciating the yuan prematurely”. I guess a lot depends on the definition of ‘premature’ in this particular instance. Do you mean that the Yuan should avoid appreciation until the demand crisis phase has passed, or that it should avoid appreciation until some other set of events occurs?”

Not even Krugman would argue that Chinese trade polices cause a secular increase in the US unemployment rate. For every job lost in the tradeable goods sector, a job is created in the investment sector.

Prematurely means before they have overcome the shortfall in AD. My guess is that they should start appreciating the yuan in about 6 months.

You said;

“If you mean immediate cause, yes. But, why were so many Chinese factory workers employed in factories that were slavishly dependent on exports to a country that was consuming far more than it produced? Who created this dependence?”

The problem was not Americans consuming too much, it was a fall in NGDP. If NGDP had kept growing at 5%, any needed adjustments in our trade balance could have occurred slowly. Also, most of Chinese exports go to other countries, but they were also hurt by the crisis. BTW, I don’t think our trade deficit is a problem, although it may be a symptom of other problems like a low savings rate.

Regarding you last question. I am not taking a position on the wisdom of China’s government saving a lot. I see pros and cons. In my view it is their call, and not up to us to second guess. I see good arguments on both sides.

OGT, I am not fan of China’s economic system. The question is given that system, how much foreign reserves should the Chinese government accumulate.

I am no fan of Singapore’s political system. It is too authoritarian for my taste. But I like their fiscal policy of very low taxes on income, and no taxes on capital and no tariffs. That part is more libertarian than most other countries. Every country has lots of bad points. We have 400,000 innocent people in prison for taking drugs.

OGT#2, Thanks for the info, it confirmed my suspicion about the 5% figure. It is difficult to know how big a role the state plays, because many firms are quasi-state, quasi-private. Pettis knows a lot more than I do, but even he probably doesn’t really have a firm grasp on the relevant magnitudes. It is very difficult to interpret China. It is likely in my view that the SOEs are gradually behaving more and more like private companies, and that this explains part of the extraordinary productivity gains you are seeing in China. Singapore Air is the classic case of a SOE that behaves exactly like a private company. The Chinese SOEs are nowhere near that point, but the situation is slowly improving in my view, even if the last year has seen a setback as Pettis argues.

“Not even Krugman would argue that Chinese trade polices cause a secular increase in the US unemployment rate.”

Neither did I up above:

“The long term argument, however – that 20 years of Chinese trade surpluses has harmed US labor more than it would have in the absence of Chinese capital controls – is significantly stronger (but not unique to the Chinese).”

The harm is primarily in wage structure associated with trading with an economy with already cheap labor that is forced to be even cheaper than market equillibrium – note your own post on real median (benefit adjusted) wages. You also write:

“For every job lost in the tradeable goods sector, a job is created in the investment sector.”

So, how is retail an “investment” sector? And is it healthy for the US to develop a financial sector that accounts for 6% of the economy? Are these jobs dynamic, and capable of sustaining long term growth rates?

And as noted, the primary objection is the overvalued dollar – of which China is simply the most egregious example.

Separately:

“Saving is not a zero sum game.”

Investment is clearly not zero sum, but savings is another matter. In the absence of an exogenous currency with intrinsic value (and I’d question how much “intrinsic value” even gold has), _net_ savings is zero sum. Money is an obligation, and every obligation has two sides.

You can argue that _total_ savings can be positive (in short, US and China can each hold vast reserves of each other’s currency). True, but why is total savings the metric of concern? I suppose the primary benefit is insulation from exchange rate risk, coupled with currencies being anchored by domestic usage (US can devalue China’s savings, but this causes domestic harm).

[…] to see whether Mr Sumner had altered his view of the situation at all in recent weeks. It seems he has not:For the moment let’s stop obsessing about our unemployment problem, and spare a thought for […]

Sumner- My impression from afar is that many of the SOE’s have taken a step backwards in the current crisis. And I don’t think they can progress much more without paying a more or less market rate for capital, meaning households getting a market rate for their own savings.

OGT, Every time I go to China (6 times between 1994-2009) the country seems better run. If anything, the change has accelerated rapidly since my 2001 trip. That partly explains my optimism. At the same time in an absolute sense it still isn’t very well run at all, except in a few areas.

I don’t think China has depressed the wages of low skilled workers. Their gains from being able to buy Chinese made goods at Walmart probably outweighs any wage cuts that result from Chinese competition.

I don’t understand your objection to us producing more investment goods. All goods are either consumer goods or investment goods–would you rather we produce more consumer goods?

And saving most definitely is not a zero-sum gaim. All countries can simultaneously save more. Money has nothing to do with saving.

Globally savings equals global investment, so one can hardly argue that investment is not a zero sum game but saving is.

“Their gains from being able to buy Chinese made goods at Walmart probably outweighs any wage cuts that result from Chinese competition.”

I agree completely here, the competition and lower prices from Walmart helped me in grad school and college immensely.

“And saving most definitely is not a zero-sum gaim. All countries can simultaneously save more. Money has nothing to do with saving.”

For modern countries this is mostly true, but for most third world countries it isn’t. A lot of “saving” among the indigenous in ecuador goes into buying wearable gold or is kept in actual paper US dollars (the USD is the currency of ecuador).

Chinese monetary policy is implemented by monetizing foreign debt–principally US and Euro debt. When the Chinese embarked on stimulating their economy during this global recession, the rising trade imbalance was mathematical. The one is an adjunct to the other.

I agree with you that it is not just the currency — there are a whole set of policies besides the currency that force the Chinese to save so much, and these policies are at the heart of the trade imbalance. But it should have been pretty obvious, I would have thought, that the focus on China makes sense, unlike the other high-saving Asian countries you mention, because the surpluses of those other countries are too small to have such a huge impact on the US, whereas the Chinese trade surplus is enormous. It matters.

Where I think you are missing the point is that the US could boost domestic demand by continuing to run up debt to stimulate demand — of course this would raise the US risk premium and its repayment would reduce future demand — or it could divert domestic demand going abroad by either forcing China to remove its export-subsidizing and import-penalizing policies, or by putting into place its own such policies. Diverting domestic demand would be a much more sustainable way for the US to do so if you believe that the US saves too little and has too much debt, which I think is a reasonably well-accepted view. Because China’s surplus is so huge, in other words, the US must address China’s surplus when it chooses between a sustainable and an unsustainable way to resolve its domestic problem.

Even ignoring sustainability issues for the US, you may be right to argue that the US should not try to resolve its unemployment problems by exacerbating those of China, but American policymakers are no more likely to take this argument seriously than would Chinese policymakers who were asked to reduce their manufacturing excess and increase their unemployment in order to help India, Vietnam, and other poorer countries (in fact other poor Asian countries are even angrier with China than are the US and Europe). Since neither China nor any other country would be willing accept high unemployment to help the poorer elsewhere, it is a little disingenuous to suggest that US should or might.

Doc Merlin, I don’t quite follow your second point. If they want to save that way, additional cash or gold will flow into Ecuador from elsewhere. And elsewhere people can save in other ways to make for the loss of cash and gold.

Jon, I agree.

JackZ, You suggest that somehow China is stopping the US from getting a trade surplus. But lots of other countries have trade surpluses, Germany’s surplus is nearly the size of China’s, and they have higher wages than we do. We should focus on getting our own house in order. We should save more. The Chinese trade surplus is not that big, it does not have a significant impact on the US economy, witch is 14 trillion dollars.

“But almost no one thinks we are going to be in a liquidity trap in 2014, indeed many believe the Fed will begin its so-called “exit strategy” this year.”
-Famous not-so-lasting words.

Leave a Reply

Name (required)

Mail (will not be published) (required)

Website

Search

About

Welcome to a new blog on the endlessly perplexing problem of monetary policy. You’ll quickly notice that I am not a natural blogger, yet I feel compelled by recent events to give it a shot. Read more...

Bio

My name is Scott Sumner and I have taught economics at Bentley University for the past 27 years. I earned a BA in economics at Wisconsin and a PhD at Chicago. My research has been in the field of monetary economics, particularly the role of the gold standard in the Great Depression. I had just begun research on the relationship between cultural values and neoliberal reforms, when I got pulled back into monetary economics by the current crisis.